Why Population Density Drives America’s Trade Imbalance

November 21, 2019

The Problem:

In my last few posts, we’ve seen a powerful correlation between America’s trade imbalances and the population density of its trading partners.  But how does that work?  It seems odd – something that seems highly unlikely to be a factor.  And you’ve likely never heard of it before.  What you have heard about are a host of other “factors,” things like low wages, trade barriers, intellectual property theft, lax labor and environmental standards, just to name a few.  All of them seem like more plausible explanations for trade imbalances than something like “population density.”

The reason population density has such a powerful effect on trade is what it does to the per capita consumption of products.  Beyond a certain critical population density, over-crowding begins to rapidly erode people’s need for and ability to use (or “consume”) virtually every product you can think of, with the exception of food.  At first glance, you might think that’s a good thing.  Everyone lives more efficiently, reducing their environmental footprint and their demand for natural resources.  However, the real problem is that per capita employment is tied directly to per capita consumption.  Every product not bought is another worker that is out of work.  As population density continues to grow beyond that critical level, an economy is rapidly transformed from one that is self-sufficient and enjoys full employment to one with a labor force that is bloated out of proportion to its market, making it dependent on other nations to sop up its excess labor or, put another way, making it dependent on manufacturing products for export to rescue it from what would otherwise be an unemployment crisis.

Let’s consider an example.  The dwelling space of the average citizen of Japan, a nation ten times as densely populated as the U.S., is less than one third that of the average American.  It’s not hard to imagine why.  In such crowded conditions, it’s only natural that people will find it impractical to live in single-family homes in the suburbs and will instead opt for smaller apartments.  Now think of all the products that go into the construction of dwellings – lumber, concrete, steel, drywall, wiring, plumbing, carpeting – literally thousands of products.  And think of furnishings and appliances.  A person living in a dwelling that is less than one third the size of another consumes less than a third of all of those products compared to someone living in less crowded conditions.  And what about the products used to maintain the lawns and gardens of single-family homes?  Consumption of those products doesn’t just reduce – it vanishes altogether.

Consequently, per capita employment in those industries involved in building, furnishing and maintaining dwellings in Japan is less than a third of that in America.  So what are all of those unemployed Japanese to do?  Will they be put to work building cars for domestic consumption?  Hardly.  As you can imagine, the per capita consumption of vehicles by people living in such crowded conditions is impacted dramatically as most opt for mass transit.  So emaciated is the Japanese auto market that even Japanese automakers have trouble selling cars there.  So now add to the workers who aren’t employed in the home industry those workers who also aren’t employed building cars for their domestic market.

And so it goes with virtually every product you can think of.  Japan is an island nation surrounded by water.  Yet their per capita consumption of products for the boating industry is virtually zero compared to other nations, simply because it’s so crowded.  There’s only so much marina space to go around.  Put a town of 100 families next to a marina with 100 slips and it’s likely that every single family will own a boat with a motor and fishing gear.  Put a city of a million families next to that same marina and, though the marina is still full, on a “per capita” basis boat ownership has effectively fallen to zero.

Japan’s only hope for employing its badly under-utilized labor force is to use them to manufacture products for export.  This is exactly why America’s second largest trade deficit in manufactured goods is with Japan.  It’s not so much that we buy too much stuff from Japan.  The problem is that Japan buys so little from us in return.  It’s not that they don’t want to.  They can’t.  Their market is so emaciated by over-crowding that they can’t even consume their own domestic production.  Why would they buy more from us?  The same is true of nearly every major U.S. trading “partner” that is badly over-crowded.  Attempting to trade freely – without tariffs or other barriers – is tantamount to economic suicide.  It’s virtually certain to yield a huge trade deficit.

Why have I never heard of this before?

Few, aside from those who follow this blog or have read my book, have ever heard of this before.  Even if you have a degree in economics, you’ve never heard of it.  In fact, you were likely taught the opposite.  If you studied economics, at some point you were surely introduced to the late-18th century economist Malthus, and were warned to never give any credence to any theories that revolved around over-population, lest you be derided as a “Malthusian,” which would surely doom your career as an economist.

In 1798, Thomas Robert Malthus published his essay titled “Essay on Population” in which he warned that a growing population would outstrip our ability to meet the need for food, effectively dooming mankind to a fate of “misery and vice.”  This led to the field of economics being dubbed “the dismal science,” something that really rankled other economists.  Yet, the idea gained some traction until, that is, as years passed and improvements in farming productivity exceeded the requirements of a growing population.  The other sciences mocked the field of economics unmercifully, proclaiming that mankind is ingenious enough to overcome any and all obstacles to growth.  Economists acquiesced and vowed to never, ever again give any consideration to any concerns about overpopulation.

And so it is today that economists have a huge blind spot when it comes to the subject of population growth.  You can’t discover something that you’re not even willing to look at.  It’s not unlike the medieval Catholic Church labeling Galileo a heretic for theorizing that the earth revolved around the sun instead of vice versa.  Where would we be today if the study of astronomy ended at that point?  Where would we be if Newton was mocked for his theory of gravity and the field of physics ended at that point?  That’s what economists have done.  They’ve turned their backs on what is arguably the most dominant variable in economics.

What does this mean for trade policy?

In the wake of the Great Depression, soon followed by World War II, economists disingenuously laid blame for what had transpired on U.S. tariffs and, eager to put to the test the theory of free trade, promised that it would put an end to such wars and depressions.  So, in 1947, the U.S. signed the Global Agreement on Tariffs and Trade, taking the first step to implement the concept of free trade on a global basis.  Within three decades, the trade surplus the U.S. had enjoyed was wiped out.  In 2018, the U.S. ran its 44th consecutive annual trade deficit which, by the way, set a record in 2018 and continues to worsen.

The problem is that the concept of free trade doesn’t take into consideration the role of population density in making over-crowded nations absolutely dependent on running trade surpluses in manufactured goods, and simultaneously sapping the life from the manufacturing sector of other nations.  No amount of trade negotiations can correct this imbalance.  No nation that is dependent on manufacturing for export would ever agree to anything that would slow their exports and it’s impossible for them to increase their imports because, after all, it’s their emaciated market that has caused the trade imbalance in the first place.  The only way to restore a balance of trade is to force the issue through the use of either tariffs or import quotas.  Any trade policy that doesn’t employ those tactics when trading with badly over-crowded nations is doomed to failure and puts our overall economy at risk.

Since World War II, other presidents have tinkered with tariffs in those rare instances when the World Trade Organization has green-lighted their use to correct for some other nations’ trade transgressions.  But President Trump is the first president in seven decades to implement a significant tariff program aimed at reducing our trade imbalance with China.  But much, much more needs to be done.  There are many other nations whose trade imbalances on a per capita basis are much worse, nations like Germany, Japan, Mexico, Ireland, South Korea, Taiwan and a host of others.  While many are allies, none of them are “allies” when it comes to trade.  All are eager to sustain and even grow their trade imbalances at the expense of American workers and families.  All want the U.S. economy to bear the cost for their overpopulation.  None want to face their own problems.  The U.S. needs to put an end to pointless – even counterproductive – trade negotiations, and do the things that are within our power to force the restoration of a balance of trade.

 


A Trump Report Card

April 23, 2019

It’s been a while since I’ve posted anything, and thought it’d be a good time to give President Trump a sort of mid-term report card, albeit a little late.  I’ll grade him in two subjects only – immigration and trade policy – since these two areas address the economic effects of population growth, both actual growth the effect of growth imported through trade with overpopulated nations, the focus of this blog.  Beyond these, little else matters.  What about environmental policy?  Without a focus on stabilizing our population (and virtually all of America’s population growth is driven by immigration), all other environmental policies are doomed to failure.  What about foreign policy?  It’s impossible to project strength in the world if you’re weak on trade.

So, with that said, let’s begin with the good news:

Immigration Policy:  A+

Trump has done a fantastic job on both illegal and legal immigration, each of which had been contributing a million people per year to America’s population growth.  Thanks both to Trump’s zero tolerance policy for illegal immigration and dramatic cuts in legal immigration, the Census Bureau reduced its estimate of the U.S. population by 1.3 million people at the end of 2018.  He spent a lot of political capital in his efforts to get funding for a border wall and, when Congress wouldn’t agree, had the guts to declare a national emergency to obtain the funds.  “What emergency?” the media cried at first, but not for long, when their own reporters in the field began reporting on the humanitarian crisis at the border that resulted from the adminstration’s efforts to enforce the law instead of turning a blind eye to illegal immigration as previous administrations have done.  Now there’s virtually no complaints about Trump’s enforcement efforts or his emergency declaration.  His policies are likely responsible for the fact that increases at the low end of the wage scale are outpacing higher income increases.  Recently, during a trip to the southern border, Trump declared that “Our nation is full.”  Truer words were never spoken.  Ultimately, this is the biggest reason that immigration needs to be reduced.  Trump has done an absolutely fantastic job of reining in out-of-control immigration.

That’s the good news.  Now for the not-so-good:

Trade Policy:  D

Such a low grade may seem surprising and harsh, especially in light of the tariffs on metals and his seemingly tough position with China, including a 25% tariff on some items and a 10% tariff on half of all Chinese imports.  However, it’s those very actions that elevate his score to a “D” from an “F”, the score I’d give to every previous president going as far back as Franklin Roosevelt.  They’ve been a nice start, but fall far short of what we were led to expect from him in the way of trade policy.  Like all previous presidents of the modern era, Trump has been sucked into endless trade negotiations, a ploy that nations with large trade surpluses have used successfully for decades to forestall meaningful action by the U.S. – namely, tariffs.  We were promised that the North American Free Trade Agreement (NAFTA) would be torn up or promptly replaced.  Trump’s administration did negotiate a new agreement, but one that reportedly does little to shrink the enormous deficit with Mexico and it may never even be enacted, if Congress has its way.

Action on China is stalled.  Tariffs on auto and parts imports now appear to be idle threats.  Beyond China, there’s been no action on reducing the trade imbalance with other nations like Germany, Japan, South Korea, Taiwan, Vietnam and a host of others.  The trade deficit in manufactured goods has continued to explode to new record levels under Trump.  Employment in manufacturing has stalled once again.  Trump sees trade as a venue for demonstrating his deal-making prowess, and he sees tariffs as leverage to use in trade negotiations.  He doesn’t understand that favorable “deals” with overpopulated nations are impossible and a waste of time, and that tariffs are the only way to restore a balance of trade with those nations.  Regarding the ongoing trade negotiations with China, he recently declared that the U.S. will win, whether a deal is reached or not.  He’s wrong.  The Chinese have already won by sucking him into time-wasting talks that, at best, will yield a deal that the Chinese will use to continue to grow their trade surplus with the U.S.  He had them on the ropes with the tariffs and then caved in, letting them off the hook.

In summary, Trump’s trade policy is stalled and our trade deficit is getting worse, not better.  This has been a major disappointment.  He’s wasted valuable time.  As I’ve said many times, a tariff program will produce some pain in the short term as prices rise and companies are slow to build manufacturing capacity in the U.S., but will ultimately yield incredible economic growth once that capacity is in place.  Had Trump been more aggressive with tariffs, the short term pain would have given way to some major economic gains by the time of the 2020 election.  Now, that’s probably not possible and, instead, his economic program is at risk of stumbling into the election.

He’s done a terrific job on immigration but all may be lost if he doesn’t get his trade policy off dead-center.


We are ruled by economists.

April 21, 2014

http://blogs.reuters.com/anatole-kaletsky/2014/04/19/time-to-stop-following-defunct-economic-policies/#comment-1696

I’ve been gone for two weeks and have a lot of catching-up to do, but thought I’d begin with something most recent.  You’ve heard me claim that there are no political solutions to our slow-motion economic demise because our political leaders simply hand over economic policy to some economist who, invariably, regardless of whether they subscribe to the philosophies of Keynes or Hayek, are pro-growth and lean heavily on population growth to achieve it.  Only by opening the eyes of economists can there be any hope for real change.

So I’m especially fond of any writings that take the field of economics to task.  The above-linked editorial appeared on Reuters a couple of days ago.  (And I especially love the opportunity to be the first to comment!)  In this piece, the author, Anatole Kaletsky, calls for “… new thinking about politics and not just economics.”  He begins with a quote from economist John Maynard Keynes:

The ideas of economists, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.

I couldn’t have said it any better.  The world is ruled not by politicial leaders but by economists.  It’s a scary thought when you realize that economics isn’t a real science at all, but something more akin to philosophy, mixed with a little psychology and some mathematical expressions of theories to lend it credibility – theories virtually devoid of facts and data to support them.  Real sciences are rooted in data, and real scientists go unafraid wherever the data takes them.  That’s why technology advances at breakneck speed while our economy limps along the edge of a precipice.  Scientists examine all possibilities.  Economists bury their heads in the sand, cowering in the face of criticism and unwilling to ponder where their single-minded devotion to growth may lead.


Cramer on Free Trade and Immigration

January 9, 2014

Did you watch NBC’s “Meet the Press” on Sunday?  For those of you who didn’t, check out this roundtable discussion of the economy with Gene Sperling, Director of the National Economic Council and Jim Cramer, host of CNBC’s “Mad Money” and former hedge fund manager.  Approximately 5 minutes and 40 seconds into the discussion, the topic turns toward globalization, free trade and immigration.  I was pleasantly surprised – stunned, actually – (and I think you will be too) at Cramer’s comments.  Essentially, he asked “why do we continue to pursue free trade” and, regarding immigration, asked “why don’t we worry about putting our own people back to work first?”

It’s a sign of cracking support for globalization and immigration when someone of Cramer’s influence begins to challenge these economists’ sacred cows.  Good for you, Jim!


The National Debt: How Big and Who Pays?

December 17, 2012

In light of the intense debate over the “fiscal cliff” – triggered by unsustainable federal budget deficits that are growing the national debt at an alarming rate – this might be a good time to revisit the national debt and put that problem in perspective.  Just how bad is it?  Who’s on the hook to pay it?  What’s the best way to fix it? 

Most economists relate the national debt to our gross domestic product, or GDP – in other words, the size of the economy.  So let’s begin there.  The following shows the growth in our national debt vs. growth in GDP:  National Debt vs. GDP, 1929-2012.  (Source:  U.S. Bureau of Economic Analysis.)  Note that the two have grown in tandem but, beginning in the early 1980’s, the national debt began to catch up to GDP and the lines crossed in 2010. 

To make it easier to understand, let’s look at the national debt as a percentage of GDP:  National Debt as Percentage of Chained GDP.  (Source:  U.S. Bureau of Economic Analysis)  The war effort (World War II) skyrocketed the national debt to 120% of GDP but, once the war ended and federal spending returned to normal levels, growth in the economy steadily outpaced growth in the national debt until the national debt fell to only about 33% of the economy in 1981.  Aside from a brief period in the late ’90s, when a bubble in the stock market and in the PC/cell phone/internet businesses generated a ton of federal revenue, resulting in balanced budgets, the national debt has grown steadily as a percentage of GDP, but really began to accelerate in 2008 when the “Great Recession” took hold.  Now the national debt exceeds our GDP, a milestone where some economists begin to fret.  How much debt is too much?  I don’t think anyone really knows.  As a percentage of GDP, some nations’ debts are actually much larger than that of the United States.  Interest payments on the debt are still a relatively small part of the federal budget, though growing. 

But who’s really on the hook for this debt?  If holders of America’s bonds decided to cash them in and demand repayment of their principal, where would the money come from?  The federal government would have to extract revenue from “the economy” in order to come up with the cash.  But that’s misleading.  Almost all federal revenue comes from the pockets of individual taxpayers.  Any revenue generated by taxing business simply gets rolled into the cost of their products and we still end up paying.  So, what’s more significant than the percentage of GDP that the national debt represents is your share of it.  How much do you owe?  Would you be able to pay it?  Here’s a chart of the national debt per capita, and how it’s grown from 1929 to today:  National Debt Per Capita, 1929-2012.  (Sources:  U.S. Bureau of Economic Analysis and U.S. Census Bureau)

Yikes!  Now that’s scary!  On average, every man, woman and child owes about $44,000 on the national debt – a new record in 2012, and climbing really fast.  That’s more than double what it was at the end of World War II.  If you’re the breadwinner for a family of four, your family owes $176,000.  Could you afford to pay that?  Few could.  Virtually no one could by having a percentage deducted from their pay in the form of taxes.  It’d have to come from your net worth – your home and your savings. 

So let’s take a look at household net worth to see just how many people could afford this.  This chart shows both the median (the point at which half of the people have higher net worth, and half have lower net worth) and the mean (average) net worth of households:  Household Net Worth.  (Source:  U.S. Federal Reserve)  First of all, as an aside, notice that the median net worth hasn’t grown at all since 1983, the year the Federal Reserve first began tracking this data on a triennial basis.  But the mean has grown nicely.  This means that the net worth of the top few percent of households has grown at a phenomenal rate.  In 2010, the median household net worth was about $77,000.  But, on average, each household owes $176,000 on the national debt.  In other words, if your net worth is anywhere near the median or less, you’re broke!  You just don’t know it yet. 

In actuality, though, the national debt wouldn’t be spread evenly across all households.  The rich would have to shoulder much more of the burden, since their net worth is much higher.  So how much would each household owe if the percentage of net worth was the same for everyone?  To calculate this, we divide the national debt by the sum total net worth of all households combined.  Here’s the chart:  National Debt as Percentage of Total Household Net Worth.  (Sources:  U.S. Bureau of Economic Analysis and U.S. Federal Reserve)

As you can see, this figure held fairly steady for decades in the 12-20% range.  But, in 2010 (following a brief period during which if fell, thanks to the bubble in housing market), it jumped to 28%, thanks to a big jump in the national debt and a fairly big drop in household net worth in the wake of the “Great Recession” a few years ago.  The point is that, if we’re all to pay an equal amount in terms of percentage, we’ll all be called upon to fork over 28% of our net worth. 

What are the odds that all of America’s creditors will want to cash out at the same time?  Slim to none.  Why would they?  They’d be paid in dollars.  Then what?  What do they do with those dollars which, ultimately, can only be redeemed in the U.S.?  Nevertheless, as the debt goes higher, so too does the risk that more and more creditors will become uncomfortable and will want their money back.  One way or the other, the debt has to begin coming down at some point, whether it’s done by the government through tax increases and spending cuts, or by creditors cashing out.

In essence, you owe 28% of your net worth to the federal deficit spending that has taken place over the decades, propping up the economy and making us all feel wealthier than we really are.  And, bear in mind that the median household net worth hasn’t risen since 1983.  Were it not for that deficit spending, most of us would actually be 28% poorer.  The unraveling of the national debt process is going to be painful.  Even if it occurs over many years, it will be a matter of the federal government withdrawing stimulus from the economy.  It’ll leave all of us poorer than we would be if the deficit spending continued – something that can no longer be sustained.

Of course, there is a way that the national debt could be cut painlessly – a way that no politician or economist has dared to address – a way that addresses what necessitated the deficit spending in the first place – and that’s fixing our trade policy to restore a balance of trade.  As I’ve discussed many times in the past, it’s no mere coincidence that the growth in our national debt closely tracks the growth in our cumulative trade deficit.  You’ll notice that, in all of these charts, things took a turn for the worse in the early 1980s.  That coincides closely with the beginning of our string of 37 consecutive annual trade deficits that began in 1976, sapping nearly $12 trillion from our economy.  Here’s that chart once again:  Cumulative Trade Deficit vs Growth in National Debt.  (Source:  U.S. Bureau of Economic Analysis)

Without tackling the trade deficit, any meaningful progress toward reducing the national debt is impossible without throwing the nation into recession.  Both parties know it.  Neither wants to address it.  Republicans love our trade policy because it’s in the best interest of their rich, corporate benefactors.  Democrats love it too – perhaps not to the same degree – because it makes people more dependent on government largesse.  But now both parties are stuck.  The most likely action is some token, trivial revenue increases and spending cuts in return for mutual agreement to address the problem in a more meaningful way, perhaps after the next election.  And the next time the debt is tackled again?  The result will be the same.


Hadas: Admit Economic Ignorance

November 3, 2012

http://blogs.reuters.com/edward-hadas/2012/10/31/admit-economic-ignorance/

This above-linked editorial by Edward Hadas appeared on Reuters this week.  Hadas calls for economists to admit that they’re “stumped” and that ignorance reigns in the field of economics.

Rather than repeat myself, the following was my reply (which you’ll find several comments down):

Good article, but the whole focus on financial machinations is illustrative of the problem with the field of economics. It focuses all of its attention there while maintaining its self-imposed ban on considering the effects of what is, by far, the biggest driving force behind economic trends today – population growth. If economists ever did consider the full range of effects – beyond mere resource issues – they might come to recognize the inverse relationship between population density and per capita consumption and its role in driving unemployment and global trade imbalances.

As rising population density chokes the life out of per capita consumption (which is inextricably linked to per capita employment), governments are becoming increasingly dependent upon deficit spending to maintain an illusion of prosperity. And even that tactic is rapidly becoming more impotent.

In conclusion, Hadas says:

Economists who can answer any of these questions deserve Nobel prizes. There is a generation’s worth to be won. Unfortunately, while the prizes can wait, policy has to be made now, in confusion and ignorance.

Can the field of economics, so bent on defending its precious mathematical models, ever wake up to reality?  I wonder.  They’re much more likely to resort to a tactic that we in the engineering world used to jokingly suggest as a solution to difficult problems:  multiply by zero and add the answer.  The Nobel prizes will likely go to economists who develop “fudge factors” that make all seem right with their models.

Perhaps only after the field of economics finds the mocking and insults that’s heaped upon them because of their ignorance greater than the derision they endured over Malthus’ theory will they decide to open their minds a little.  In the meantime, they will continue to wallow in ignorance and our political leaders, under their advisement, will continue to serve up ignorant economic policy.


Want Less Federal Government Intrusion? Focus on Trade Policy.

February 15, 2012

One of the biggest rallying cries of the right these days is ever-greater intrusion by the federal government into our lives.  They have a point, and the health care reform enacted in President Obama’s first year in office is a case in point.  It’s instructive to examine that case to gain insight into just why the federal government plays an ever-larger role in our lives.

Why was health care  reform enacted?  Well, the fact that Democrats held both branches of Congress and the White House certainly played a part; there’s no denying that.  But public sentiment also played a big part.  Employers had been jacking up premiums for health care insurance for years until they were no longer affordable.  More recently, in the wake of the near-depression, more employers were simply canceling such benefits altogether.  More people were faced with the only option left – buying individual policies on the open market – a real eye-opener for people who’d been used to paying group rates. 

People had had enough.  They wanted something done.  Something was.  And the mandates necessary to make it work – especially the mandate for everyone to obtain insurance – especially the young and healthy – came as a bitter pill to swallow.  (Of course, no one complained when they were mandated by their employers to participate in the plan.) 

So, in this case, this “intrusion” by the federal government into our lives was precipitated by slow but steady growth in the imbalance in the supply and demand for labor that made it possible for employers to cut benefits without fear of losing employees.  And the same is true for many federal spending programs.  As state and local budgets force cuts in education, in police and fire protection, in infrastructure spending, etc., the federal government steps in with grants and stimulus spending to make up the difference.  Otherwise our society would slowly collapse.  And, as is the case with all money, federal money comes with strings attached. 

Ultimately, it is the trade deficit that lies at the root of ever-more pervasive federal intrusion into our lives.  To better understand this, you need to understand the international flow of dollars caused by trade.  This won’t be anything new to those of you who have read Five Short Blasts. (See Figure 8-1 on page 143.)  For the benefit of others, that understanding begins with the simple fact that every dollar that is shipped overseas to purchase imported goods must eventually return to the U.S. – one way or another – since the U.S. is the only place where U.S. dollars can be spent.

“Not so,” you might say.  “Oil is priced in dollars.  China can use their dollars to buy oil.”  Very true.  However, that leaves oil exporters like Saudi Arabia with a growing mountain of dollars that still can only find a home in the U.S. 

Dollars come back to the U.S. in various ways:

  1. For the purchase of American exports
  2. For direct investment in the U.S., as in the case of a foreign automaker building a plant in the U.S.
  3. Indirect private investment, such as the purchase of corporate stocks and bonds.
  4. Indirect public investment, such as the purchase of government bonds. 

Regarding item no. 1, only a little over half of the dollars spent on imports come back in the form of export purchases.  Regarding no. 2, net direct investment in the U.S. is actually negative.  More dollars are invested overseas than in the U.S., making the challenge of attracting dollars back to the U.S. that much greater.  Regarding no. 3, we already have heavy foreign ownership of American companies.  To continue to pour money into their stocks and bonds would simply create a market bubble that would soon collapse, as the stock market did in March of 2000.  (And, by the way, it was precisely this kind of foreign investment in mortgage-backed securities that led to the collapse of the housing market and financial institutions in 2008.) 

That leaves one option – no. 4 – the purchase of government issued debt, or Treasury bonds.  As long as we continue to run a trade deficit, it’s absolutely vital to the economy that the government issue debt to draw those dollars back into the U.S.  But that’s not enough.  The mere purchase of bonds does nothing to offset the harm done to the economy by imports.  The only way to actually plow those dollars back into the economy is through federal spending. 

Now, suppose that you’re a state – say California.  The citizens of California spend their money on imports – a net outflow of cash.  Like virtually every state, it is required by its constitution to balance its budget.  As it attempts to do so, imports steadily drain money from the state.  So each year, state revenues which are a fixed percentage of the state economy, continue to decline.  The state must cut more spending:  cut funding for schools, lay off police and firemen, cut pensions for state workers, etc. 

There is only one way to keep the economy of California (and every other state) from decline, and that’s for the federal government to inject money back into the economy.  To make a long story short, Californians’ money goes to China, Germany, Japan and others.  Those countries then use the money to purchase treasuries from the federal government.  The federal government then plows that money back into California in the form of federal grants to repair school district budgets, rehire police and firemen, pay unemployment benefits and, yes, to pay for new health programs to offset the cuts of those benefits in the private sector.  And the biggest program for injecting money back into the economy is tax cuts, offsetting the downward pressure on wages wrought by the imbalance in the supply of labor.

It’s a vicious circle, and there’s only one way to break it – by restoring a balance of trade.  No trade deficit – no need to issue federal debt.  No federal debt – no money to plow back into the economy.  No federal money (with strings attached) coming back into the economy – no more intrusion by the federal government in our lives.

What’s going on in Greece today is a perfect example of what would happen without this mechanism to plow federal dollars back into the economy.  Just like the U.S., Greece has a huge trade deficit.  It too relied upon debt to offset the negative consequences.  However, once it became a member of the European Union, it lost its ability to grow its debt further.  It became like a U.S. state.  But, in the case of the EU, its members don’t get money plowed back into the economy throught the issuance of EU debt.  The EU is loaning money to Greece, but demands that it be repaid.  The EU hasn’t yet figured out that this is an unsustainable recipe for depression for its members with trade deficits. 

Yes, it’s unsustainable for the U.S. to continue to grow its debt forever, too, but as long as the U.S. continues to run a trade deficit, it’s absolutely vital to keep the economy afloat.  The president recently proposed a budget for 2013 with a deficit of $900 billion.  Given that the trade deficit in 2011 was $737 billion and is growing fast, it’s very likely that the trade deficit will be about $900 billion in 2013.  It’s no coincidence that those two numbers match. 

The longer we run a trade deficit, it’s unavoidable that the federal government will play a bigger role in our lives.  Those who complain about such intrusion by the federal government into our lives are wasting their breath.  Unless we all turn our focus to the trade deficit, we’d just better learn to accept the strings that come attached to the federal money that keeps us all afloat.